Answers provided in brackets, please show how answers were derived.

7. You are examining the viability of a capital investment that your firm is interested in. The project will require an initial investment of $500,000 and the projected revenues are $400,000 a year for 5 years. The projected cost-of-goods-sold is 40% of revenues and the tax rate is 40%. The initial investment is primarily in plant and equipment and can be depreciated straight-line over 5 years (the salvage value is zero). The discount rate to be used for this project is 10%. The project makes use of other resources that your firm already owns:

(a) Two employees of the firm, each with a salary of $40,000 a year, who are currently employed by another division will be transferred to this project. The other division has no alternative use for them, but they are covered by a union contract which will prevent them from being fired for 3 years (during which they would be paid their current salary).

(b) The project will use excess capacity in the current packaging plant. While this excess capacity has no alternative use now, it is estimated that the firm will have to invest $ 250,000 in a new packaging plant in year 4 as a consequence of this project using up excess capacity (instead of year 8 as originally planned).

(c) The project will use a van currently owned by the firm. While the van is not currently being used, it can be rented out for $ 3000 a year for 5 years. What is the NPV of this project? Are there any issues with calculating the IRR? (Ans. $-42,660.88. Yes)